Taxpayer bailouts spur move to tighten banking rules

Almost a decade after the Continent’s first troubled lenders began to implode, Europe’s taxpayer-funded bailouts of banks still aren’t a thing of the past.

How to end the controversial rescues will top EU financial policymakers’ agendas this autumn, when they take up the European Commission’s proposals to revise a suite of banking rules put in place after the financial crisis.

In late June, the Italian government asked the Commission for permission to inject about €4.8 billion in cash — and to guarantee loans worth €12 billion — into two Venetian banks as they were liquidated and pieces of them sold off to a bigger, healthier bank. The rationale: Rome’s intervention prevented a sudden collapse of the two banks, which would have severely disrupted the economy of the affluent northern region.

This was, however, a blatant example of public money being used to help private financial institutions. And it wasn’t the first such case that month. Earlier in June, the Italian government also saved Monte dei Paschi di Siena (MPS), the country’s third-largest bank, with the Commission’s blessing.

Taxpayer bailouts of banks are exactly what the EU’s wide-ranging set of post-crisis rules were supposed to prevent. But the fact that they haven’t has led certain critics — in particular in Germany — to opine that the current rules are not fit for purpose. And they spot an opportunity to beef up the rules when Brussels policymakers return from the summer break and re-examine the entire banking package.

Bible for banks

On November 23, 2016, the Commission proposed its revised banking rules in five separate pieces of legislation containing risk-reduction measures for banks. As part of that, the Bank Recovery and Resolution Directive (BRRD) — the bible for “bailing in” troubled banks with their investors’ money as opposed to bailing them out with public funds — is being revisited.

The proposed rules revise capital and bail-in legislation put in place since the crisis for the biggest financial institutions. Although the bail-in directive is technically only being amended to incorporate new, internationally agreed-upon rules to ensure that banks have sufficient funds to be resolved, some see this as their chance to tighten standards to prevent a repeat of what happened with Italian banks.

The Greens in the European Parliament, for example, have already put forward a raft of amendments to close the “existing loophole,” said Sven Giegold, a German MEP from the group. “We’ll then see who supports these proposals.”

The Council, under the presidency of Estonia, is aiming to reach a general approach on the proposals by the end of its term in December. An Estonian presidency official said the current rules are “not perfect, but they will be improved.”

But detractors already warn that the new draft rules may not be right for legacy issues, such as the nearly €1 trillion worth of bad loans sitting on EU banks’ balance sheets. They question whether revised rules would make any difference in handling long-running cases.

The Italian government’s use of national insolvency laws to rescue the two Venetian banks — Banca Popolare di Vicenza and Veneto Banca — was perfectly legal. It was just not what EU policymakers perhaps had in mind when they assured that taxpayer bailouts had ended in 2009.

The Commission permitted the use of state aid because it concluded that although the two banks’ failure would not hurt the financial stability of the EU and therefore was not in the “public interest,” such an event would have gone against the “common interest” of the Italian region with heavy job losses.

MPS was propped up under a different provision in EU banking rules — via a government-led “precautionary recapitalization.” This is a tool that allows the use of public funds subject to certain conditions, including that the bank is solvent and can prove its ability to return to health.

Whether justified or not, some parliamentarians, Germans in particular, feel that the Italians have abused the system and are likely to take a hard line in coming negotiations.

That doesn’t mean their views will necessarily prevail.

Nicolas Verón, a senior fellow at Brussels think tank Bruegel, doesn’t see a need for major changes, praising the current rulebook as working exactly as it was meant to. Brussels, in fact, has another successful case of regulator-forced resolution — that of Spanish lender Banco Popular — to demonstrate that. Investors in the banks have seriously disagreed with the EU’s handling of the case, however, with at least two major groups of bondholders and shareholders challenging the legality of the process that led to hundreds of millions of euros in losses.

Correcting typos

“My view from a policy perspective is there is nothing that justifies an urgent change in BRRD beyond correcting typos,” he said. “But at a political level, there are [different] views.”

Gioacchino Foti, a lawyer at Clifford Chance in Italy, also argued that the BRRD was not yet “fully in gear.” Once banks have built up sufficient levels of eligible liabilities for bail-ins, “we will probably not see the situation where there is an intervention of the state to rescue the banks,” he said. “We should not judge the framework of the BRRD by looking at the Italian banks situation, which was largely driven by legacy issues.”

Potential challenges to upcoming negotiations don’t stop at revising the BRRD. The proposals are accompanied by a revised Capital Requirements Regulation and Directive, a Single Resolution Mechanism Regulation, and a creditor hierarchy to stipulate which instruments are bailed in first.

The Commission sold the package as “risk reducing” for banks, but some politicians and Council officials immediately decried the proposals as falling short.

All of this means the package is unlikely to sail through Brussels.

And until the “risk reduction” measures are final, there is little chance for the EU’s banking union to become a full reality. The European Deposit Insurance Scheme — a key pillar of the union — will continue to stall until richer EU countries feel comfortable sharing risk with poorer ones.

Tri-party talks on the package will kick off once the Parliament and the Council have finalized their negotiating stance. While the Council is set to do so by December, the Parliament’s timetable is not so clear. MEPs at this point are aiming to publish only a report on the Commission proposals by the end of September.